New Pension Plans Provide Educators With Options, Risks
Teachers and administrators in 27 states are finally free to ride the nation's bucking financial markets after years of watching from the stands—a trip that is proving both liberating and painful.
Now that many of them have won the freedom to invest their retirement money as they like, this new generation of investors is being subjected to the volatility of the stock market, including its recent dives, along with all the other investors.
"There are macroeconomic changes—war, peace, stagflation, downsizing of the economy—that have tremendous effects on the stock market and people's rates of retirement," said John D. Abraham, the senior associate director of research for the American Federation of Teachers.
"What are these Enron employees going to do now?" Mr. Abraham said, referring to the collapse of the Houston-based energy giant that resulted in the loss of many employees' life savings. "If they had defined-benefit plans, they'd all be in pretty good shape."
Throughout much of the 1990s, educators found themselves locked into inflexible pension plans while family and friends took advantage of the booming stock market. Under those defined-benefit plans, teachers' retirement savings were guaranteed by their employers, but they could not decide how or where to invest their money.
At about the same time, states began to replace or supplement such traditional plans with systems that allow public school educators to choose their own investment portfolios.
Such changes are an attempt by legislators to give teachers, administrators, and other school employees more control over their own savings, improve recruitment, and reduce the financial risk to state governments. They also mirror a national trend apparent in the private sector.
"States are beginning to look at ways to increase employee benefits and transfer some of the investment risk to [the employees]," said Barbara J. Perry, the vice president of public retirement plans for TIAA-CREF, a New York City-based company that handles investments for teachers in all 50 states.
"They also want to provide for more outsourcing of administrative duties," she said
Teachers and administrators, in turn, are becoming savvier and want the option of managing their own money, Ms. Perry said. They recognize that they can take risks with their savings earlier in life and enjoy bigger payoffs, she said.
Despite the variety of investment choices, Ms. Perry added, first and foremost, workers need to be realistic about the amount of money they'll need to retire. Then, they can make an educated decision about which type of investment plan best meets their needs.
The traditional programs—defined-benefit plans—were born shortly after the Great Depression, according to Matthew P. Lathrop, the task force director for commerce and economic development for the American Legislative Exchange Council. The Washington-based organization is made up of lawmakers and other policymakers who stress free-market approaches to public policy.
Both public and private employers offered workers guaranteed retirement savings without regard to fluctuations in the market, Mr. Lathrop said.
Most teachers dedicated small amounts from their paychecks to their retirement savings, money that was matched by the state and the school district. The combined funds were then added to a pool and invested by state retirement boards in diversified portfolios.
Upon retirement, educators were due a fixed amount of savings in compliance with a complex formula, and dependent upon the number of years worked. The employer was legally obligated to pay out the expected nest egg—no matter how the investments had done in the market.
Teachers enrolled in defined-benefit plans who leave the profession before they're fully "vested" in their plans, or who move from state to state or district to district, are at a disadvantage, Mr. Lathrop said.
Most states mandate educators stay in the plan for anywhere from six to 10 years before they can collect a portion of their savings, meaning they're vested; all employer contributions are lost if the educator leaves before his or her specified date, Mr. Lathrop said.
Those who are vested and leave before that date often must also pay high penalty fees—in some cases, thousands of dollars— for removing their money from the state pension funds.
The scenario is the same for vested teachers who move out of state, Mr. Lathrop said.
"The guaranteed benefit is only good for those who spend a substantial part of their career with one employer," he said. "That's an enormous drawback in today's economy, when even public employees are less likely to stick with a single employer."
Moreover, defined-benefit plans don't allow educators to choose their own investment portfolios, he said. They simply must abide by the decisions made by state boards authorized to control the investments. Such portfolios are generally safe bets, he said, but don't grow as quickly as other, higher-risk investments that may be especially appealing to younger teachers.
States at Risk
And from many policymakers' point of view, defined-benefit plans are particularly risky for state governments. When the market tumbles or lawmakers inadequately finance the account, states may find themselves with empty coffers and a responsibility to pay out pension checks.
Such a situation was looming in West Virginia more than a decade ago, according to David A. Haney, the executive director of the West Virginia Education Association. He worked on a state committee to overhaul the state's retirement system.
"We had $250 million in assets, as opposed to $3.2 billion in unfunded liability," Mr. Haney said. "It would have been just a couple of years until [the program] was apt to be bankrupt."
In 1991,the state began offering K-12 teachers and other school employees a defined-contribution plan in place of the defined-benefit plan, he said. The arrangement was meant to benefit employees and the state alike: Educators can direct their own investments, and the state can transfer the risk to the employee.
To date, about 18,000 of the 43,000 eligible people in West Virginia participate in the new plan, Mr. Haney said. All new teachers must join the program; veteran educators have the option of participating or continuing in the old, defined- benefit plan.
Florida, Louisiana, Ohio, South Carolina, and Washington state have followed suit in offering some form of defined-contribution plan.
For example, South Carolina offers the program only to new teachers. Veterans, however, can supplement their defined-benefit plans with defined-contribution investments. Florida, meanwhile, offers employees the choice of participating in a defined-benefit or defined-contribution plan.
Twenty-one other states have kept their defined-benefit systems intact, but at the same time, have begun offering employees opportunities to take part in supplemental defined- contribution plans. The option is designed, in part, as a prerequisite for educators who are not going to get salary increases.
Some observers say they see defined-contribution plans as a tool for recruiting teachers during a period of shortages in many districts and subject areas.
"Under the [defined- benefit] pension plan, vesting required 10 years of service," said Walter W. Kelleher, the defined-contribution coordinator for the Florida State Board of Administration, which offers pension programs to public employees. "How could we recruit anyone to Florida?" Florida's new program has a one-year vesting requirement, he said, with the aim of attracting more educators.
Such plans "could be one way of helping to attract high-quality teachers, particularly if they're older," said Mildred Hudson, the chief executive officer of Recruiting New Teachers, a Belmont, Mass.-based nonprofit group that promotes such efforts. Those considering teaching as a second career would do so knowing they had the opportunity to make some money for retirement, she said.
But critics worry that states and employees who rely on defined-contribution plans will be disappointed by the results. Poor returns on investments mean that teachers have little savings.
"We support the prevailing system, namely defined-benefit plans, and a supplemental defined-contribution plan ... because you want to have a balance of sources of income for your retirement years," said Cynthia L. Moore, a lawyer for the National Council for Teacher Retirement. The Sacramento, Calif.-based organization represents states and districts on retirement issues.
Others are concerned that teachers aren't receiving enough instruction on the process of investing. "The state has a moral, ethical, and legal obligation to provide education about retirement and investments," said Mr. Haney of the West Virginia Education Association. "I don't think they've met that obligation."
A study conducted in West Virginia last year, he said, showed that 50 percent of teachers did not understand how the new plan worked; 70 percent said they would like professional-development sessions on investing.
Despite such concerns, 5th grade teacher Susan B. Mathews wishes she had at least been offered the opportunity to participate in her state's new defined-contribution plan. The program is now offered in South Carolina, but only to beginning teachers, said the educator, who works at River Springs Elementary School in a suburb of Columbia.
"I would love to have any kind of choice," said Ms. Mathews, who has been in the profession for more than 20 years and is 54. "I do not have enough money in my retirement account. I feel like I need to work until I'm 62 to make it worth my while."
Vol. 21, Issue 29, Pages 1, 22-23Published in Print: April 3, 2002, as New Pension Plans Provide Educators With Options, Risks